World financial markets have become less concerned about North Korean risk……………

World financial markets have become less concerned about North Korean risk: equities have largely recovered from previous setbacks, and ”safe haven” buying of government bonds has eased back. Whether this persists or not remains to be seen.  According to a Bank of America Merrill Lynch survey of large fund managers released this month, there has been an increase in levels of insurance protection against equity market corrections over the next 3 months. But at the same time, as we have reported in recent newsletters, the VIX volatility index would indicate that investors were more worried about the Chinese economy slowing down in early 2016 than they are now about North Korea going nuclear.

Globally, the business cycle continues to improve which provides a generally good backdrop for corporate profits, though this is partly countered by some major central banks readying to remove some of their previous monetary policy support.   Although there are hints of improvement, there is still no strong evidence the Australian economy has broken out of its period of slower than usual growth, which will be a precondition for better returns from local equities and property.

We might spend a bit more time on the Australian Dollar than we usually do as it is proving very unpredictable and the knock-on impacts are meaningful.  The RBA has continued to note that an appreciating (rising) Australian dollar should cause both economic activity and inflation to lift more slowly than it would expect – or hope for that matter. We want these two measures to pick up and it is no secret that a much needed kickstart to the Australian economy is delayed or weakened by our persistently high currency.

What I find particularly interesting is a marked divergence of opinions over where our dollar is headed and of course much of this is out of Australia’s control given that it is more the strength or weakness of the US dollar that prices ours.  While the ANZ, NAB and Westpac predict an Aussie dollar in the low USD$0.70 range before the end of 2018, the CBA sees even more buying and predicts the Australian dollar to be sitting around USD $0.85 instead.  “Anything might happen” seems to be the prevailing guidance which, obviously, is not very helpful to anybody.

But, as with interest rates, foreign exchange forecasting is an inexact business and it is more likely in my view that some event will take place or certain economic data will take a course that shifts momentum one way or the other and all of these rather long-range predictions will be quickly reset.  That still doesn’t help forecasting much.

Chart:  Australia’s Key Economic Indicators* ….


Sources:  Morningstar Research;  CBA Research & ComSec; *CHART:RBA 6 Sept 2017.